Positives and negatives of gearing
About the author
Jane Slack-Smith has been named one of the Top 10 Property Experts in Australia by Money Magazine, one of the Top 4 Financial Influencers by Qantas and been awarded the Australia’s Mortgage Broker of the Year twice.
Negatively gearing an investment property is viewed by many Australians as a tax-effective way to get ahead and indeed, despite the pandemic’s shake-up of the rental and property market in 2020, our love of bricks and mortar as an investment remains unabated.
Even in the depths of the pandemic, one in four Australians believed that now was the right time to make a property investment, and almost half saw property as their strongest investment option.i
Property is by far the largest asset class in Australia, often making it a key component of any balanced investment portfolio. The nation’s combined residential and commercial property market is worth more than $8 trillion, compared to the $2.7 trillion we have saved in superannuation and the $2 trillion invested in the ASX.ii
For individuals who invest in property, negative gearing holds some appeal. In the latest figures, Australian taxpayers were claiming $13 billion a year in negative gearing – a number that looks set to keep growing.iii
So, what is gearing?
Basically, it’s when you borrow money to make an investment. That goes for any investment, but property is where the strategy is most commonly used.
Negative gearing is when you offset a loss from your investment(s) against your assessable income, therefore reducing your overall tax liability. This can occur if the rental returns from an investment property are less than the amount you pay in interest for your loan and any outgoings related to the property.
In contrast, positive gearing is when the income from your investment is greater than the outgoings and you make a profit. When this occurs, you may be liable for tax on the net profit you receive but you could still end up ahead.
While negative gearing may prove tax-effective, it’s dependent on the after-tax capital gain ultimately outweighing your accumulated losses. As we have seen over the past 12 months, while the long term outlook with property is generally an upward trend, property prices can decrease at times.
It’s also important to have sufficient funds in reserve for any unforeseen circumstances such as the property being untenanted or major repairs.
How does negative gearing work?
Say an investor bought a property that generates $20,000 annually in rent, but their annual interest bill is $25,000, with a further $4,000 in expenses – that’s a loss of $9,000 per year. While that’s clearly a negative, there is a positive side to this shortfall. In Australia an investor can offset the costs of the investment against their personal income tax, reducing their overall tax bill. Not only can investors claim the interest on the mortgage but they can also claim other allowable expenses associated with the property such as the rates, repairs and any depreciation.
For those on the top tax rate, these concessions can lead to a significant reduction on their overall tax bill. However, for someone who pays no tax or low tax, then these deductions may have little or no value.
Quality wins out
Negative gearing should not be the aim of an investment but rather a means to an end. It’s important to make a good investment in the first place that is in line with your investment and lifestyle goals. If the property doesn’t increase in value over time, then it’s likely an investor would be out of pocket overall.
While negative gearing may sound attractive, that doesn’t mean it will work for everybody in all cases, so it’s important to do your homework to ensure your investment is profitable.
If you are looking to finance a property investment, we can help you to find the best deal for your situation.